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May 17, 2011

End of QE2? Not a Problem, Say ING Investment Management CIOs

Fed has successfully injected liquidity into the economy, recovery is self-sustaining, says ING

The end of QE2 does not mean the end of the party for credit, and the U.S. economic expansion will stay on track after June 30, said ING Investment Management fixed-income experts on Tuesday in New York.

“The strategic view is that we’re overthinking this thing,” said Christine Hurtsellers, ING Investment Management’s chief investment officer of fixed income and propriety investments, of the Federal Reserve’s second round of quantitative easing, scheduled to finish on the last day of the second quarter.

The end of QE2 will pass quietly because the Fed’s plan to inject liquidity into the U.S. economy has essentially worked, according to the ING experts. Gross domestic product will be higher in the second quarter, inflation is not a serious near-term risk, and the Fed won’t raise rates until 2012, they predict. In addition, U.S. companies are now stable enough that they can create a self-sustaining recovery.

While the recovery has been a slow and fragile one, companies enjoy plenty of liquidity, and even consumers are now taking on more debt, noted Paul Zemsky (left), chief investment officer of multi-asset strategies.

“Our view is that the end of QE2 is a risk but it’s not the training wheels falling off the economy,” Zemsky said. As for the average American, he added, “we’re in an expansion but to most people it doesn’t feel like it.”

In fact, they say, the end of QE2 will create a great opportunity in credit and risk assets in what will be a continued low-rate environment in the near term.

However, Zemsky warned, the government’s debt build-up could lead to a crisis in the U.S. economy in the medium term if politicians don’t address it.

A larger and more immediate risk is the danger of government debt presenting a greater headwind to GDP, he said. Nominal personal consumption expenditures are at an all-time high, and while labor income is rising at a 4% rate, inflation could easily cut into higher wages. Zemsky predicted inflation at a rate of 3.5% to 4% this summer.

For investors, both Hurtsellers (left) and Zemsky said they are bullish on high-yield bonds. Corporate balance sheets are in such great shape that this trade will do well, Hurtsellers asserted, adding that she is less enthusiastic about investment-grade credit because companies are so cash-heavy. Corporate leverage as measured by the ratio of net debt to EBITDA is near a 10-year low, while liquidity as measured by cash balances as a percentage of debt is near a 10-year high.

Hurtseller said that she anticipates a tactically rocky ending to QE2. Certainly, she said, the yield curve will inevitably start to re-steepen. Nevertheless, there will be opportunities in fixed-income over the next eight months, she asserted, pointing to both senior loans as an inflation hedge and opportunities in emerging market debt (EMD).